Jil Matheson, the National Statistician, today opens a public consultation inviting views on a range of options for the way the Retail Prices Index (RPI) is calculated. The consultation closes on 30 November 2012.
As a result of work to understand the reasons for the differences between the RPI and the Consumer Prices Index (CPI) estimates of inflation, the National Statistician is inviting users’ views on the way the RPI is constructed. The differences between the RPI and CPI under consideration are those caused when different formulae are used to calculate average prices where there is no information about precise expenditure. This is known as the ‘formula effect’. The consideration of change is part of a programme of work to maintain the quality of the statistics.
The National Statistician is seeking responses on the following options:
1. No change. This option would leave the formula effect as it is.
2. Change one particular approach to averaging changes in prices, which calculates the average of price relatives (the amount a price changes over time for the same type of item where there is no information about consumers’ precise expenditure), for clothing. It is for the clothing category that the difference between the CPI and RPI formulae has the greatest effect. Options for the method to be used in its place are discussed further in the consultation document published today. This option would reduce but not remove the formula effect as some differences between the RPI and CPI formulation would remain.
3. Change one particular approach to averaging changes in prices, which calculates the average of price relatives (the amount a price changes over time for the same type of item where there is no information about precise expenditure), for all categories that use it. Options for the method to be used in its place are discussed further in the consultation document published today. This option would reduce the formula effect, although some difference between the RPI and CPI formulation would remain.
4. Change the RPI so that its formulae align fully with those used in the CPI. This would remove the formula effect between the RPI and CPI, although there would remain differences between the estimates produced by each because of the different coverage, weights and scope used.
The consultation also seeks feedback on a proposal to amend the data source for private housing rental prices. Both the RPI and CPI include measures of change in the price of private housing rents. The consultation invites views on proposals to change the data source for the measurement of these prices. Subject to the consultation responses, this change would be introduced in March 2013.
The consultation runs from today, 8 October 2012, and closes on 30 November 2012. Depending on the results of the consultation, the National Statistician may put forward recommendations. The National Statistician first announced her intention to consult, including the consultation options, on 18 September 2012.
Any recommendation for change would be published in January 2013 and would be subject to the governance arrangements set out in Section 21 of the Statistics and Registration Service Act 2007 (see background notes for further detail).
For further information and details on how to respond please see the full consultation document.
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Statutory provisions concerning changes to the Retail Prices Index
The Statistics and Registration Service Act 2007 established the UK Statistics Authority (referred to as the “Statistics Board” in the Act), as an independent body, at arm’s length from government, reporting directly to Parliament. The Authority is responsible for promoting and safeguarding the quality of official statistics.
The Authority is required to ensure the compilation and maintenance of the RPI and that it is published it every month. The National Statistician is the Authority’s principal adviser on statistical matters. The Office for National Statistics (ONS), as the Authority’s executive office, is responsible for the production and publication of price index statistics. Changes may be made to the coverage and the basic calculation of the RPI, although in certain circumstances, under section 21 of the Act changes may only be made with the consent of the Chancellor of the Exchequer following consultation with the Bank of England.
Section 21 of the Statistics and Registration Service Act 2007:
“(2) Before making any change to the coverage or the basic calculation of the retail prices index, the [Statistics] Board must consult the Bank of England as to whether the change constitutes a fundamental change in the index which would be materially detrimental to the interests of the holders of relevant index-linked gilt-edged securities.
(3) If the Bank of England considers that the change constitutes a fundamental change in the index which would be materially detrimental to the interests of the holders of relevant index-linked gilt-edged securities, the Board may not make the change without the consent of the Chancellor of the Exchequer.”
The Explanatory Notes accompanying the Act:
“This is because, among other things, the RPI is used to calculate returns on [index linked gilt-edged securities] ILGs, which are government securities issued by HM Treasury under its borrowing powers in section 12 of the National Loans Act 1968. The prospectuses of ILGs first issued before July 2002 provided as follows:
“If any change should be made to the coverage or the basic calculation of the [Retail Prices] Index which, in the opinion of the Bank of England, constitutes a fundamental change in the Index which would be materially detrimental to the interests of the stock-holders, Her Majesty‟s Treasury will publish a notice in the London Gazette immediately following the announcement to the relevant Government Department of the change, informing stockholders and offering them the right to require Her Majesty‟s Treasury to redeem their Stock in advance of the revised index becoming effective …”
The prospectuses of eight gilts with maturities ranging from 2009 to 2030 currently contain this redemption clause and the aggregate outstanding amount of these gilts is substantial. There are now five gilts in issue containing the clause, with maturities ranging from 2013 to 2030.
The rationale of the redemption clause was to protect holders against arbitrary changes in the nature of the RPI. However, depending on the nature of the change to the RPI and on market circumstances at the time, the triggering of the section could have a significant impact on financial markets and potentially on the public finances.
Subsection (3) provides that if, under subsection (2) the Bank of England considers the proposed change to constitute a fundamental change that would be materially detrimental to holders of ILGs, then the Board may not make the change without the consent of the Chancellor of the Exchequer.”
Therefore, in the event that the National Statistician was to recommend a change to the RPI that, in the opinion of the Bank of England, constitutes a fundamental change in the index that would be materially detrimental to the interests of the holders of relevant index-linked gilt-edged securities, and the Chancellor were to consent to such a change, then HM Treasury would publish a notice informing stockholders and offering them the right to require HM Treasury to redeem their Stock.
HM Treasury has informed ONS that it will provide advance notice, via its website, of the date the consent or otherwise, if required, of the Chancellor of the Exchequer to any change would be published in the event that a change to the RPI is recommended. The Debt Management Office (DMO) will circulate this notice among market participants by way of a screen announcement.
Other uses of the RPI include setting wage increases, indexation of rail fares, for indexing some pensions and in contracts.
Formulae used in the RPI
There tends to be a lack of reliable expenditure data for products at the lowest level of price collection (for example, canned fruit), meaning it is not always possible or meaningful to derive weights in either quantity or value terms for individual products within tightly defined commodity groupings (for example, for tinned peaches or tinned pears). In these circumstances it is accepted practice to assign an equal weight to each price observed. In the RPI, price indices at the lowest level are predominately calculated using a simple arithmetic average.
The average of price relatives (also known as the Carli) is calculated as the arithmetic average of price changes.
The ratio of average prices (also known as the Dutot) is calculated by dividing the arithmetic average price in one period by the arithmetic average price in a reference period.
Consumer Prices Index
The CPI uses a geometric approach (known as the Jevons) to average items where there is no information about precise expenditure. As with the RPI, further information on the geometric average is given the Consumer Price Indices Manual and is included in the consultation document published today.
There are no proposals to change the way the CPI is calculated because of the very limited use of the arithmetic average formula for items at the lowest level of price collection.
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